Friday, November 14, 2008

We're all gonna die!

Not really, but it probably seems that way if you read newspapers (not that any still does that, but you get the point).  Bad news about the economy continues to roll in (lower consumer spending, higher unemployment, etc.) and no one is sure when it will end or what to do about it.

First, let's establish an important point. This is *not* going to be the next Great Depression. It might be a recession as bad as the 1980-82 one, which is bad. But take a deep breath and tell yourself that we are not headed into a new Depression. If you remember back a few posts, one of the defining elements of the Depression was DE-flation. We do not have deflation, and this makes all kinds of differences.  In addition, the people in charge (Bernanke) may not understand why this is all happening, or exactly how to get things turned around, but they DO know how to keep us from getting deflation. They have printing presses, and can start shucking out dollars, which will prevent deflation.  So we WON'T end up in another Depression.

Now, we will have a pretty painful recession (or more accurately, are in the midst of a one). At this point, the reasons for why this happened seem to be less important that the policy choices we have to make to get out of this mess. We can worry about blame later.

Paul Krugman made a nice distinction about the current situation.  He said we are not in a Depression (nor will we be), but our policy options look like those in the Depression.  Simply put, here are the government options for what to do:
1) Lower the interest rate
2) Lower taxes
3) Raise government spending
4) Do nothing

Bernanke has already done 1), and the Fed Funds rate is so low now that there is little scope for further cuts to improve the situation. Lower interest rates should make borrowing cheaper, so that people will buy more homes and factories. In other words, it should make purchases today cheaper than purchases tomorrow, so we should buy more today and increase aggregate demand, increasing output and reducing unemployment. BUT, the lower interest rates have not generated this effect (probably because people are so spooked that no one wants to buy much of anything) and further cuts in interest rates are unlikely to work either.

So what about 2)? Lower taxes (e.g. send out stimulus checks to everyone) should push up aggregate demand. If the government sends you $2000, the idea is that you'll spend that on new stuff, and this will increase demand, raising output, and reducing unemployment. However, you might use that $2000 to pay off some existing credit card debt or pay down some other debt. Or you'll just save it in case you do lose your job. This is the big issue with stimulus checks, what percent of them will people actually spend?  If they save all the money, the stimulus is a waste.  Why? Because the government borrowed the money from a bank to send you $2000, and then you basically put that $2000 right back into the bank. There is no difference in the assets of the bank, and you did no additional spending. So if you just save the $2000, no good comes of it.

That leaves us 3), raise government spending. This has the advantage of being, well, spending. The government could do a variety of things, all of which have floated around the news lately.  They could start a national infrastructure program (to replace those bridges like the one in Minneapolis that collapsed), or they could transfer funds to state and local governments to fund their own projects (build a new school, upgrade a sewer, etc..), or they could subsidize "green" energy research by pumping money into research, or they could incent companies to get green by subsidizing the purchase of clean technologies.  Heck, we could just invade Iran. That would incur a lot of government spending.  The point is that the government *spends*.  They buy stuff from companies, who then hire more workers, who get paid, who then spend more money, etc..  But unlike the tax breaks, we are at sure that there is some initial spending.

Of course, the government could do 4), nothing. This seems unlikely to it isn't really worth dwelling on.

The point is that only increased government spending is likely to be effective. So IF we should increase government spending, we should at least do it smartly.  That is, let's get something worthwhile out of it.  We could build a 12 lane highway between Missoula, Montana and Witchita, Kansas.  That would be increased spending, and would help.  But long run, it's just a waste of resources.  You'd like to government to spend on things that have the potential to a) increase current economic activity and b) have a long-run benefit.  Things like infrastructure replacement (e.g. replacing useful roads that are in disrepair) or increasing education or something that has benefits. We'll all disagree on which projects qualify, but we should at least agree on the principle.

Does the proposed auto bailout qualify? It would increase current economic activity.  Actually, it would technically stop current economic activity from getting lower, but that is effectively the same thing.  So the question is whether bailing out GM and Ford has any long run benefits.  I can see several.  Like, um, you know, people like cars?  And, er, they're both really cool?

My point is that there seems to be little long-run benefit to an auto bailout.  These companies are reaping what they and their unions sowed over the last 50 years.  They are inefficient, bloated, and incapable of keeping up with their competitors. They should go into bankruptcy and try to sort out their problems. 

If you wanted to spend government money on bailouts for their employees, then I'd be more amenable to the plan. Still a rip-off, since most of their employees are members of the UAW, and have allowed their union to put them in this situation, but whatever.  GM has 300,000 employees.  Offer each of them $100,000 - that's a total of $30 billion.  Do the same for Ford and Chrysler and you probably have to spend $60 billion, far less than the $250 billion thrown around to keep inefficient companies afloat.

Just saying.

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